From the January 2004 issue of Investment Advisor • Subscribe!

A Patient Man

Jeff Auxier operates his mutual fund the same way he runs his farm: he's patient and has a long-term perspective, but still does the daily chores. So far, the harvest has been quite abundant

Farming and investing might appear to have little in common on the surface, but you'd be surprised at how closely related the two activities actually are. "If you plant trees you're not going to get a return right away," explains Jeff Auxier, president and CEO of Auxier Asset Management, L.L.C. in Lake Oswego, Oregon. "You have to think long-term, but you've also got to do your day-to-day work." The same goes for investing, he says. "There are no shortcuts in farming, and a good investor has to be committed to working hard every day and to doing the research." Each morning Auxier, fund manager and founder of the Auxier Focus Fund [AUXFX], rises at 4:30 a.m., tends to his 58-acre hazelnut and timber farm just outside of Portland for a few hours, and then heads to his office for a full day of investment research. "I believe focus is the key to achievement in all areas," he says of the single fund he manages. Auxier puts all of his energy--and most of his own money--into Auxier Focus.

If farming and money managing seem an unlikely pairing, Auxier Focus takes a unique approach. Unlike most mutual funds, AUXFX isn't restricted to holding only one cap size, sector, or country. Instead, there are three simple criteria Auxier uses when selecting his investments: price, value, and margin of safety. "The fundamentals will drive your portfolio," he says. "If you try formula investing every time, it doesn't work. Things change."

His approach seems to work despite the market's volatility since the fund's inception in July 1999. For the three-year period ended November 28, 2003, Auxier Focus Fund had an average annualized total return of 10.4%, versus a total return of -5.5% for the S&P 500 Composite Index, and -0.5% for all large-cap value funds, according to Standard & Poor's. The fund has posted higher than 10% returns each year since inception. The fund is ranked 11th within the entire universe of 819 funds in this peer group, and posts five stars in all categories from S&P.

We recently spoke with Auxier about his fund's sterling performance, his bare-bones approach to investing, and why farming--as much work as it can be--is a good way to avoid Wall Street hype.

What does the word "Focus" refer to in Auxier Focus Fund's name? The focus has to do with the focus [or the investment philosophy] of the firm. There is a misconception that it refers to five or 10 specific stocks, but it doesn't.

What was the catalyst for creating the fund? It was mostly a fulfillment of a dream. When I first got into the business, I wanted to know who the best investors were, so I called Warren Buffett. It was in 1982 right before the Forbes 400 issue arrived. I remember calling him and a few weeks later sitting down to read the Forbes issue. I almost fell out of my chair to find out how highly rated he was. He was very generous with his time. He gave me the names of some great people, so I flew around the country and met them. My goal when I got into the business was to be a great investor and to master the skills of capital allocation. I felt that was the best way to help a lot of people.

Tell me about your management style. We have wide latitude when it comes to investing. My attitude is to find great investments and then let the money compound as opposed to switching it around all the time. We can buy virtually anything, and put the power of compounding above everything else. Our focus is to avoid permanent loss of capital.

Because compounding is so critical, we focus first on how much risk is in each investment. The investment can be a large-cap or a small-cap stock or bond or whatever. We don't really want to count on the market to make us money; we want to count on an exceptional pick. We have a business analyst's approach. If you buy a business at 50% of its value and it compounds at 12% a year over five years and then it goes to 100% of its value, you make 20% compounded over that five-year period, so what we are trying to do is take advantage of wide discrepancies between price and value because of the emotions of the market. All auction markets have volatility, which we don't see as risk; we see it as an opportunity to buy an asset that has been mispriced. It is a rational approach. We want to know what we own better than the markets know it. So when the market becomes irrational, we want to be there.

From 1984 to 2002, average mutual fund investors achieved only a 2.6% return because of their emotions. They bought the hot fund and then sold it when it went down. When I got into the business, I wanted a systematic, low-risk approach to investing. The mutual fund industry is based on sales, but it is not based on what the client needs. A client in his 50s needs something that is systematic with low risk. He also wants to stay the course to keep compounding, not wild swings that knock him out of the game.

What about the distribution of the fund? We look at each investment and wherever the widest gap of price and value is--the one that has the greatest margin of safety with the highest return potential--will get most of the money. We are always going through the portfolio saying this is undervalued, fairly valued, or overvalued. We want, and watch, really good businesses. As a businessperson I want to buy the best businesses that have a high return on invested capital, that are consistent, that are run by honest, competent managers. When those businesses go on sale, we are right there to take advantage of it. The best ideas are the ones that have the lowest risk with the highest reward--and the best positions become the bigger holdings in the portfolio.

When superior businesses are crushed with a temporary but solvable problem, that's when we come in. We are always looking at the portfolio and saying, "Okay, because of compounding we want that high-return, low-valuation, low-expectation company with improving fundamentals, priced at an unusually low discount."

The flip side of that is avoiding what are called torpedo stocks. These are high-expectation, high-priced companies, and when they blow up, it's like the Enron situation. Those are the ones that just kill the compounding in the portfolio. We focus on those compelling situations, and if they are just mediocre, we won't invest in them.

So are current holdings reviewed daily? I look at the portfolio and fundamentals every single day, although we try to have low turnover. We are always asking, "Where can we go wrong?" It is probably a little too much, but I see [investing] like a sacred mission. These clients have entrusted us with their hard-earned money and the worst thing you can do is treat it casually.

Sometimes you have a manager who has worked his entire life and then you have someone who is 25 years old with no experience running your money. The average mutual fund manager has something like three years of experience, and to me it takes something like 20 years to get even close to mastering running money.

You are talking about people's life savings! Money is one thing that people really care about, and managers are in a position of stewardship. You have to do dogged research every day as opposed to having a bunch of formulas or low P/E. You have got to know these things in their entirety--the balance sheets, the management teams, everything.

What kind of support staff do you have? We have a team of about seven people. And we follow Buffett's approach to investing-- we try to have no meetings, be more intensive on the research effort, search for facts, and not have conflicts of interest.

If much of your money is in the fund and most of your net worth is on the line, you think a lot more about it, especially when you can't get out of it. We set up the fund so that I can't sell one share if I am running it. I believe mutual fund managers should have to invest their own money by mandate and not be able to get out.

S&P classifies this fund as a large-cap value fund--do you agree? Most of the time we are in large-cap value. What we are looking for is the highest-quality investments you can buy at the best prices, and most of the time they are in that category. But we do have the latitude to buy others; we always want to have that margin of safety so we do ship the money to where things are compelling. When corporate bonds were compelling we bought them up. Right now the risk in government bonds is really high and the reward is really low. For the most part, our experience for the last 18 years has been in the bigger names, like industry leaders that are in slower-growing industries.

How do you define value? In an ideal world, we are looking for companies that have high returns on invested capital, management that has high integrity, and management that has a lot of shares. Once we identify that kind of business, we wait for the price to come down, and that will determine when we move. If the price isn't right, we won't move; something could be the greatest company in the world but if it is overpriced we are not going to buy it.

We know what we want to own, and usually when everything looks terrible, we buy. Then we can go for five-year multiple expansions. You can make an attractive return over a five or 10-year period. If you overpaid, like in the bubble of March 2000, it is almost impossible to make money. Price determines when we move.

Is there one sector you tend to stick with because of its value? We stick to those that are more understandable. The question is, is it a good business and, then, is the price right? There are a whole bunch of bad businesses out there and we try to find ones that have strong franchises.

Say, for instance, you are investing in an airline. Take all the variables where you can get hurt, like energy or labor. When compounding someone's money. you are trying to eliminate problem areas. I want to have a high degree of certainty that in five years those numbers are going to be close to what we are projecting. And there aren't that many industries out there for us. Processors are great because you are not going to change things like your paycheck provider. We need businesses that have a fairly high degree of predictability.

What index do you benchmark against? How closely do you manage to the index?

Typically we follow the S&P 500, but first we start with compounding. Clients want to be up every year and want to beat the market. That, of course, is a bit unrealistic, but we do focus on standing compounding returns every year. If the markets are way up, we try to match them, and when they are flat to down, we try to outperform them. The mentality of compounding is that when you are down 50%, you have to go up 100%; if you are up 50% in year one, up 50% in year two, and then down 50% in year three, you are better off getting 8% compounded. We don't blow up the clients on the downs.

We want to take the toughest index--universally the S&P 500 is what everyone has trouble beating--and then we say, "Okay, over time we want to beat the index and then add 2%, 3%, or 4% a year." We have beaten the S&P since inception and for three and half years we are up 56%. When you truly understand the power of compounded returns, you really have a strong aversion to losing money. The index is important to beat. If we can't beat the index, then the clients shouldn't hire us.

Where do you see this fund fitting into someone's portfolio? I would try to find those managers that have some talent but also have a great work ethic. I have 100% of my retirement money and most of my net worth in this fund, and I think everyone has the same objective: they want to make a good return with low risk. I would be comfortable having 100% of my money in this fund. This is an all-weather fund.

This fund doesn't have a 12(b)-1 fee. Has that hurt distribution among advisors? Where do most of the asset flows come from? It's funny because we haven't gone through advisors at all and we have just started going into supermarkets. I believe so strongly in compounding, we really haven't focused on the marketing side of it. My belief is if you can consistently beat the market and your money is right there, you really don't have to worry about the money.

How can investors regain confidence in the mutual fund business, which has had a stellar reputation until now? I think investors should try to find truly committed managers who have most of their own money in their funds, are committed long-term, and then have their advisor monitor that. The problem is that there is no way to tell what the behaviors of someone running my money are, or how they act; there is no choke factor. The big thing is the accountability. Mutual funds should be run more like publicly traded companies. If you are running a fund, you should put most of your money in it and not [be able to] sell it. If things were going to get ugly, the manager would take measures to protect the shareholders because he would be a significant shareholder. A lot of times you will get someone whose mandate is to beat the S&P, no matter the risk. There needs to be more disclosure on the managers and their background; somebody might have a great 20-year record but they might be golfing all day. Just like 401(k)s, you go into them and you can't tell who the managers are. The better managers should get compensated more and the poorer mangers should get compensated less.

What is your view of the overall market and the economy, particularly in light of Iraq, continuing terror troubles around the globe, and the presidential election year? I have never seen as much stimulus as I see now. You have a Medicare bill, the war in Iraq, a highway bill coming in the first quarter of 2004, an energy bill, and the tax cuts. And that could create a lot of bubbles, especially this Medicare bill.

There is so much money coming in, it could drive valuation levels ridiculously high, a backdrop that's pretty good for equities but bad for bonds. It seems everyone rotated their money into bonds at the wrong time. Bonds are highly risky now because of [Fed] policies and the dropping dollar.

There is stimulus from the dollar, low interest rates, government spending, and the tax cuts, and at some point we are going to pay for it. You wonder if we are saving for the long-term and if the dollar is reflecting our lack of thrift.

We are still looking at the business, the management, the price, and the value. Those are the first considerations, the problem is you can get so tied up focusing on the macro that you miss out on some great companies that are doing really well. The key to investing is to focus more on the underlying operations of these businesses. But by the same token, there has been a lot of cost-cutting over the last three years. That's put us in a sweet spot because companies are not adding many people and there is not a lot of capital spending, so profits are going to look really good.

A war is usually very good for stocks, but bad for currencies and fixed income. Unfortunately, I think many people put their money into government bonds and do not know the risk. And with low mortgage rates, some people have taken their equity down so low they don't have a margin of safety, though ironically it is a good backdrop for companies. Ultimately, if you overpaid for an asset, you are going to get hurt.

How does running a farm impact your investing career? I got exposed to a great work ethic on a farm as I was growing up; it is one of those things that you have got to work at every day. In today's world, there is a lot of junk and I wanted something to keep the values intact.

Staff editor Megan L. Fowler can be reached at mfowler@ia-mag.com.

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